Law and Insurance

AIG Executive and Attorney Jailed Over D&O Insurance Dispute In Mexico

Now we know why there are far fewer insurance coverage disputes in Mexico than in the U.S.  The policyholder gets to file a criminal complaint for fraud and have the insurer's management taken to jail. 

Apparently, TV Azteca S.A. de C.V. submitted a claim under its Directors and Officers Insurance Policy, which the insurer, AIG Mexico Seguros Interamericana, S.A. de C.V., denied.  "Fraud!" said Azteca.  So in late April, AIG's, general manager, Luis Ferrara Perini and AIG's outside attorney, Nestor Diaz Barriga, were jailed.  Just this week, AIG apparently paid the claim and the individuals were released.  See AIG Executives Released From Jail, reported in May 5, 2008 edition of Business Insurance.

I say "apparently" because much of the story is based on comments from brokers involved in the case who, for obvious reasons, wish to remain anonymous (and unincarcerated). 

Gives a whole new meaning to Alternative Dispute Resolution.

Houston Court of Appeals Exonerates Agent's Misstatement of Coverage

Brown & Brown of Texas, Inc. v. Omni Metals, Inc., 2008 Tex. App. LEXIS 2065 (March 20, 2008), See Omni Metals Decision.

If this decision stands, then let the word go forth: customers and additional insureds, never, never rely on a certificate of insurance, insist in all cases on getting a copy of the named insured's policy, and read it carefully. 

The named insured, Port Metal Processing, Inc., stores large coils of steel for processing.  Its customer, Omni Metals, used Port's services over the years and continually asked Port to verify insurance coverage for Omni's products while stored with Port.  Port maintained a bailee's liability policy covering property of others stored in Port's facility, but the policy excluded coverage if Port charged a fee for storage, which it did.  Port obtained the policy from Transcontinental through an agent, Brown & Brown (actually, a predecessor named Poe & Brown -- this case was first appealed in 2000).

Now, here for me is the kicker.  Port's president actually read the policy, noticed the exclusion and asked the agent if the exclusion applied to Omni's product.  The agent said the exclusion only excluded property unrelated to Port's core business, and the steel coils were covered.  The agent issued a number of certificates of insurance over the years for Omni's benefit stating that Port purchased the bailee's liability policy covering "all risks" of direct physical loss to property.  The certificates also had the usual disclaimers the the certificate was informational and did not change the actual terms of the policy.

A fire destroyed Port's warehouse including Omni's product.  Transcontinental denied the claim, and all kinds of litigation followed.  This lawsuit was brought by Omni against both the insurer and agent (earlier litigation with Port had settled).  The trial court dismissed the case based on the exclusion.

One of the oddities of this case is that Houston state courts are subject to the co-extensive jurisdiction of two courts of appeal, in the the 1st and the 14th Districts (the 1st District used to be Galveston, but after the 1900 hurricane practically destroyed the city and other historical developments, the District was moved to Houston).  In 2000, Omni appealed the case, which the clerk randomly assigned to the 14th District.  The appellate court found that both the actual statements and the certificate were actionable misrepresentations and reversed and remanded back to the trial court for fact findings by a jury to determine if Omni relied on the alleged misrepresentations.

The jury brought a verdict favorable to Omni, and the insurer and agent appealed, this time drawing the 1st Court of Appeals.  Ignoring the legal findings of the 14th Court, the 1st Court held that Omni, as a stranger to the policy, could not, as a matter of law, have relied on any statements made to Port, and could not have relied on the certificate of insurance because of the Texas Supreme Court's statement in Via Net v. TIG Ins. Co., 211 S.W.3d 310 (Tex. 2006) that "those who take [certificates of insurance] at face value do so at their own risk."  Reversed and rendered that Omni take nothing.

This decision drew a vigorous dissent (see Dissent) regarding both the majority's disregard of the 14th District's "law of the case" (meaning that a legal decision made on appeal should not be reconsidered on a subsequent appeal of the same case), and its distortion of the Via Net decision, which addressed the applicable statute of limitations in a failure-to-procure insurance case.  Via Net had nothing to do with an agent's liability for misrepresentations in a certificate.

But neither the majority nor the dissent (nor the 14th Court for that matter) drew any distinction between the agent and the insurer, even though Transcontinental asserted that Poe & Brown was not its actual or apparent agent.  Based on the facts related, coverage under the policy is not the issue.   It is the law in Texas that an insurer will not be bound by misrepresentations in a certificate of insurance (barring liability for the agent's misrepresentations).  So I don't see how Transcontinental is on the hook here, unless Poe & Brown was the agent of the insurer (not Port's agent).  The key is the agent's liability for misrepresentation.

Poe & Brown knew that Port charged Omni for storage.  The agent also knew that Omni was asking Port about coverage.  And, asked point blank if the exclusion applied to Omni's product, the agent gave Port a false yet plausible explanation of the exclusion.  Both Port and Omni were justified in accepting the agent's explanation despite what they may have thought the policy said.  This is the dictionary definition of the tort of negligent misrepresentation.

I hope this panel of the 1st District Court of Appeals will reconsider the dissent's arguments.  If not, I hope the 1st District Court of Appeals will reconsider the decision en banc.  If not, I hope the Supreme Court considers the decision.  If not, never, never rely on a certificate of insurance or, for that matter, an agent's explanation of policy language.

New York High Court Allows Consequential Damages For Breach of Contract

Bi-Economy, Inc. v. Harleysville Ins. Co. (N.Y. Feb. 19, 2008) (see Bi-Economy Decision)

The highest court of New York has joined a number of other states that have allowed policyholders to recover consequential damages in excess of the policy limits for a first-party insurer's breach of contract.  "Consequential damages" are those that flow naturally and foreseeably from a breach but are beyond the direct damages that the parties actually contemplated, or probably contemplated, when the the contract was made. 

The seminal case illustrating the distinction between ordinary damages and consequential damages is Hadley v. Baxendale (England 1854) in which H., a mill owner, contracted with B., a carrier (we would say trucker today) to transport a broken mill wheel to engineers for repair by a specified date.  B. failed to deliver the wheel on time, and H sued for damages, including the lost profits for the extra time he lost while the mill was shut down.  B. protested that he was never told that H needed the wheel to keep his mill running, and the damages should be limited to those that were generally foreseeable by the parties at the time of contract.  The court agreed with B that a common carrier was not in a position to appreciate the likely effect of a shipping delay of cargo.  Nevertheless, the principle stuck that the party breaching its contract may be liable for indirect or consequential damages, such as lost profits caused by the breach, if the parties could have reasonably foreseen the consequences had they thought about it.

In this case, a meat market sustained inventory and structural damage from a fire.  The company was insured by a policy that covered loss form fire, including "business interruption," a common type of coverage for lost profits over defined period of interruption caused by the insured peril.  The period of interruption in this policy ended with the repair or replacement of the property, but no more than 12 months.  As often happens, the insurer and policyholder disagreed over valuation issues.  The insurer offered much less for the loss than the insured claimed and agreed to pay no more than 7 months of interruption, even though the company never returned to operation.

The dispute was submitted to alternate dispute resolution.  After more than a year, the insured was awarded more than twice what was offered.  The policyholder then sued for breach of contract and bad faith, alleging that the insurer improperly delayed payment for the direct loss and the full amount of its lost profits, and seeking consequential damages for the complete demise of the business, an amount in excess of the policy limits.  The insurer argued that, in addition to other defenses, the policy itself contained several exclusions of "consequential damages."  The lower courts granted the insurer's motion for summary judgment.

The New York Court of Appeals reversed and held that the insured's loss of its business was a foreseeable and probable result of the insurer's refusal to timely pay to restore the property and the lost income.  The dissent argued that the majority was confusing consequential damages with punitive damages.  The majority responded that consequential damages are designed to compensate a party for reasonably foreseeable damages, and so must be measured by actual loss.  Punitive damages, by contrast, are designed to punish or serve as an example and need not bear a close relation to the plaintiff's actual loss.  At any rate, the Court held that limiting an insured to the amount of the policy, "money which should have been paid by the insurer in the first place, plus interest, does not place the insured in the position it would have been had the contract been performed."

A few other states have awarded consequential damages as a bad-faith remedy.  See Lawton v. Great Southwest Fire Ins. Co., 392 A.2d 576 (N.H. 1978) (Allowing only policy limits plus interest would not make policyholders whole or discourage insurers from delaying a reasonable settlement); Beck v. Farmers Ins. Exch., 701 P.2d 795 (Utah 1985)(compensatory damages under policy may exceed policy limits and include damages for economic loss and mental anguish when those damages are reasonably foreseeable).

I am unaware of any Texas case that has awarded consequential damages in excess of the policy limits.  Texas does provide an 18% per annum statutory penalty for delay of payment of a first-party claim (Tex. Ins. Code Sec. 542.051).

Texas Supreme Court Does About Face on Frank's Casing Decision: Insurers May Not Reserve a Right of Reimbursement For Uncovered Claims

Excess Underwriters at Lloyd's, London v. Frank's Casing Crew & Rental Tools, Inc., #02-0730 (Tex. Feb. 1, 2008) See Majority Opinion

The Texas High Court first decided this case in May 2005 causing a near fire-storm among policyholder and defense-bar interest groups.  I commented on this reaction and the reasons for it last April (Why Has the Frank's Casing Decision Got Everybody So Upset?).  In a nutshell, the Court originally held that a liability insurer, defending under a reservation of rights, may accept a reasonable settlement offer within policy limits while continuing to reserve its rights to contest coverage and seek reimbursement for amounts allocable to uncovered claims.  The policyholder must repay the insurer even if it does not consent to the insurer's right to reimbursement, as long as the policyholder agrees that the settlement amount is reasonable.

Why the heated response?  The 2005 decision arguably puts the onus on the policyholder to accurately evaluate both the reasonableness of the settlement and the merits of the insurer's coverage defenses, something insureds are rarely experienced at but insurers do for a living.  Also, the defense bar screamed because the original decision appeared to offer the policyholder a way out if it did not agree that the settlement offer was reasonable.  But defense counsel is typically expected to evaluate settlement demands both for the insured and the defending insurer.  However, doing so after the 2005 decision might harm the interests of the insured (by pronouncing the demand as reasonable), but refusing to do so might violate duties owed to the insurer.

So the Supreme Court has now retreated from its original position and decided that the insurer may reserve rights to reimbursement only if that right is stated in the policy or the insured gives "clear and unequivocal consent to the settlement and the insurer's right to seek reimbursement."  In so holding, the Court expands the reasoning it adopted in Texas Ass'n of Counties County Gov't Risk Mgmt. Pool v. Matagorda County, 52 S.W.3d 128 (Tex. 2000), in which the insurer attempted to reserve a right of reimbursement of a settlement that the insured neither consented to nor opposed (Frank's Casing not only agreed the settlement was reasonable but demanded that Lloyd's accept it). 

The Matagorda County Court recognized that either the insurer or the insured must be left to face a difficult choice.  If the insurer is barred from reserving a right to reimbursement, it must either refuse to accept a reasonable settlement within policy limits, relying on the strength of its coverage defenses, yet risk breaching its Stowers duty to accept a settlement demand within policy limits, or accept the settlement and avoid the risk of extracontractual damages, yet lose forever any right to show that the claim is not covered. 

If the insurer can reserve a right to reimbursement, the insured is put to the hard choice of rejecting the insurer's offer to pay and thereby risk both a much larger judgment plus losing the coverage fight, or accepting the settlement offer and face the risk of reimbursement.  The Court decided to shift the risks of decision to the insurer, holding that, even if the insured agrees that the settlement is reasonable and urges the insurer to accept it, the insurer may not reserve a right of reimbursement without the clear consent of the insured.

Three justices vigorously dissented.  Justice Hecht joined by Green (Dissent 1) argued that "a balanced, practical, and principled rule for resolving the issue presented by this case" is to allow a party disputing its obligation to perform to go ahead and perform the duty but reserve its right to restitution if the other party is benefited beyond what it bargained for in the contract.  (This principle is embodied in The Restatement (Third) of Restitution and Unjust Enrichment, Sec. 35).  Noting that the lower court found that the policy in fact did not cover the alleged claims, and also noting that Frank's Casing was "a substantial business," Justice Hecht argued that the balance of equities should be determined on a case-by-case basis, which the majority rejected.

Justice Wainwright dissented on other grounds (Dissent 2).  He stated, "I would conclude that there is no right to reimbursement.  Absent the parties' entering into a legally enforceable agreement, I do not believe the equities of the parties' respective circumstances alone support allowing a right to recoup the settlement payment."  Yet, in this case, Justice Wainwright would find that by acquiescing to Lloyd's payment, Frank's Casing in fact entered such an agreement.

Assuming no further alterations to this decision, insurers will, from now on, have to choose between continuing to contest coverage or accepting reasonable policy-limit settlement demands.  In Texas, insurers may pursue coverage actions while the underlying lawsuit is pending.  No doubt, we will see an increase in such actions.  Policyholders, who before now blanched at commenting on the reasonableness of demands, are now free to join with the underlying plaintiff in pressuring the insurer to avoid Stowers breaches and accept the demand.

Perhaps most important, we have now recently seen three major coverage decisions from this Court favoring the interests of the policyholder (the PAJ Decision and the Lamar Homes Decision).  Given the number of insurance cases still pending before the Supreme Court, the trend is likely to be significant.

Delayed Dissent Filed In Lamar Homes Case Against Applying Delay Penalty To Defense Costs

In August of this year the Texas Supreme Court issued a groundbreaking decision in Lamar Homes, Inc. v. Mid-Continent Cas. Co., 50 Tex. Sup. Ct. J. 1162 (Tex. August 31, 2007) that resolved two long-standing controversies: "occurrence" and "property-damage" coverage for defective construction (see my discussion, Texas High Court Allows CGL Coverage of Construction Defects), and application of a statutory delay penalty in first-party claims to defense costs under third-party liability parties (see my discussion at Texas Insurance Code Delay Penalty Held Applicable to Defense Costs).  Notably, three justices dissented on the construction-defects issue but not on the delay statute.  Now, the three dissenting justices have weighed in with a vengeance against the notion that an insurer's obligation to pay defense costs as part of its duty to defend under a liability policy could be a "first-party claim" under Tex. Ins. Code Sec. 21.55 (now Art. 542).

From their opening salvo, "[S]ince Reconstruction prompt-payment penalties applied to some insurance claims in Texas, but never to a liability carrier's duty to defend," the dissenters attacked the majority's reasoning on numerous grounds.  First, the majority had distinguished between a "first-party claim" (one payable to the insured) from "first-party insurance" (that indemnifies the insured's loss).  The dissenters demonstrated that the terms "first party" and "third party" had consistently and exclusively been applied over the years and under several statutes to the traditional distinction between third-party liability insurance and first-party indemnity insurance.  The majority's distinction was a completely novel one.

Second, the dissent launched a three-part attacked against the logic of applying the notion of "first-party claim" to the duty to defend.  The duty to defend is not a payment obligation, according to the dissent, it's a service obligation.  Second, reimbursement of defense costs is not the same as paying a claim under the policy contract because the insurer typically pays less to defense counsel it chooses than counsel hired by the insured after the insurer has denied the defense obligation.  Third, the dissent argued that defense costs are not "paid directly to the insured" as the statute definition requires, and payment to defense counsel is not, as the majority stated, "a distinction without a difference."

The dissent also forcefully argued that "the very operation of the statute precludes applying it to the duty to defend."  In effect, the dissent argued that applying the terms of the statute to the duty to defend is like forcing a square peg into a round hole (my analogy).  To make a fit, the majority must dispense with certain provisions required under the statute, such as securing a final proof of loss.  Moreover, if the test of a "first-party claim" is that the insurer pays money directly to the insured, then, the dissent points out, reimbursing the insured for a judgment or settlement it paid is just as much a "first-party" payment as reimbursing defense costs.

The dissent is unlikely to persuade the majority to change its ruling, so it remains to be seen how the courts will work out the details of how the delay penalty will be applied to the duty to defend.

Dallas Court of Appeals Refuses To Expand Texas Stowers Duties On Liability Insurers

Cain v. Safeco Lloyds Ins. Co. (Tex. App.--Dallas, November 29, 2007) (See Safeco Decision)

This case features a doomed effort to expand an auto insurer's bad faith liability for allegedly mishandling the defense of a lawsuit.  The plaintiff was a passenger in a car involved in a single car accident.  Safeco insured the driver.  Safeco repeatedly offered to settle the ensuing lawsuit by paying policy limits, but the plaintiff refused and obtained a $4 million judgment at trial.

Taking an assignment of the driver's rights under the policy, the plaintiff sued Safeco seeking damages in excess of the policy limits under bad-faith theories under common law and the Texas Insurance Code, including an unusual claim to extend the insurer's Stowers duties to include negligent defense of the underlying lawsuit.  Under the Texas Stowers doctrine, an insurer of a covered claim is required to exercise that degree of ordinary care and diligence which an ordinary person would exercise in the management of his/her own business in responding to settlement demands within policy limits. (Stowers Furniture Co. v. American Indem. Co., 12 S.W.2d 544 (Tex. Comm'n App. 1929)  The insurer that unreasonably refuses to accept a settlement demand within policy limits would be required to pay a judgment against the insured in excess of the policy limits.

Safeco never received a demand within policy limits, and in fact offered several times to settle for policy limits.  Therefore, Safeco never breached its Stowers duty under current law.  Cain, however, sought to expand current law by arguing that the Stowers doctrine has expanded the duty to provide a reasonable defense to the insured, and Safeco failed to provide a reasonable defense.  For support of this theory, Cain relied on two earlier cases holding that an insurer's duty of care included investigation and preparation of a lawsuit and reasonable attempts to settle.  (Ecotech Int'l, Inc. v. Griggs & Harrison, 928 S.W.2d 644 (Tex. App.-San Antonio, 1996; Wheelways Ins. Co. v. Hodges. 872 S.W.2d 776 (Tex. App. Texarkana 1994). 

The Dallas Court of Appeals refused to expand the Stowers doctrine and pointed out that after the Ecotech and Hodges cases, the Texas Supreme Court abolished the common law duty of good faith and fair dealing under most liability policies (Maryland Ins. Co. v. Head Indus. Coatings & Serv., Inc. 938 S.W.2d 27 (Tex. 1996)) upon which the earlier cases were based and also absolved the insurer of liability for mishandling the defense by defense counsel (State Farm Mut. Auto. Ins. Co. v. Traver, 980 S.W.2d 625 (Tex. 1998)).  Moreover, the Cain Court refused to create new law by expanding the Stowers doctrine beyond the limits prescribed in American Physicians Exch. v. Garcia, 876 S.W.2d 849 (Tex. 1994).

Cain's attorneys are presumably not ignorant of current law.  This case is interesting because it illustrates how the law changes.  Practitioners take a shot at establishing a new defense or (in this case) a new theory for liability.  The canons of legal ethics do not bar attorneys from making arguments for reasonable extensions of existing law when they have a good faith basis for doing so.  Most such attempts do not succeed, particularly in the lower courts.  But hope springs eternal that at some time the idea whose time has come will be received and new law will be made.  The law evolves, for good or ill, by efforts such as this.

Primary Co-insurer Owes No Duty to Other Co-insurer Who Pays More Than Its Share of Settlement

Mid-Continent Ins. Co. v. Liberty Mutual Ins. Co., #05-0261 (Tex. October 12, 2007)

The Texas Supreme Court decides in this case that a primary liability insurer may refuse to contribute its fair share to settle a lawsuit on behalf of its insured without breaching any duties to a co-insurer that pays more than its fair share.  The dispute arose out of an auto accident allegedly caused in part by hazardous road signs and barriers set up by a construction contractor.  As often happens, the contractor had liability coverage not only from its own policy, but also from subcontractors' policies covering the contractor as an additional insured.  In this case, Liberty Mutual provided both primary and excess coverage to the named-insured contractor.  Mid-Continent covered the subcontractor but also covered the contractor as an additional insured.  Each policy had $1 million limits.  Liberty's excess layer was $10 million.

In settlement negotiations, all the carriers agreed that the injured claimants would likely recover $2-$3 million at trial.  Liberty agreed at mediation to settle all claims for $1.5 million and demanded that Mid-Continent contribute half of that.  However, Mid-Continent insisted on paying no more than $150,000 based on an unreasonable assertion that the claims were worth no more than $300,000.  So Liberty paid all of the $1.5 million (less Mid-Continent's $150,000) but reserved rights to pursue Mid-Continent for its proportionate share.

The lower court held that Liberty could recover the overpayment of its fair share either because Mid-Continent owed a direct duty under the "other insurance" clause in its policy, or because Liberty had a right of subrogation to recover the over payment under its "other insurance" rights.  (The identical "other insurance" clauses in the two policies said that the insurance was primary and would share proportionately with other primary insurance available to pay the claim.)

The Texas Supreme Court reversed and held that Mid-Continent was within its rights to offer less than its share to the settlement.  First, the court re-stated an earlier holding (in American Centennial Ins. Co. v. Canal Ins. Co., 843 S.W.2d 480 (Tex. 1992)) that one insurer owes no direct duty to another even though it might owe an indirect duty.  In the Canal case, a primary insurer refused to accept a reasonable settlement within its policy limits, forcing an excess insurer to pay a judgment over the primary limits.  The primary insurer's act clearly would have breached a duty to the insured if the insured had not had excess coverage.  So the Canal court held that the paying excess insurer could step into the shoes of the insured and seek subrogation (the indirect claim) against the breaching primary insurer.

In this case, however, the Court refused to extend the Canal holding where two co-primary insurers were disputing their proportionate obligations to fund a settlement.  The Court provided several explanations for its holding, but probably the most compelling reason was stated in a concurring opinion.  Since Liberty had a $10 million excess policy, it had its its own selfish reasons for wanting Mid-Continent to split the $1.5 million settlement.  "Insurance companies are not eleemosynary institutions" wrote the concurring justice.  Where the interests of the insured are not at issue, the Court could find no basis for barring "hard line negotiations" among co-equal primary insurers, particularly where one of the insurers was protecting its own excess exposure.

The big question about this decision is the deterrent effect it may have on settlements.  The Court believes its decision will not prejudice insureds because it only limits duties owed to co-insurers.  However, policyholders may be adversely affected if fewer cases settle due to inter-insurer bickering.  We must wait and see what impact this case has on settlements in general.

5th Circuit Keeps the Door Shut against Extracontractual Remedies Under Federal Flood Insurance Program

Wright v. Allstate Ins. Co., # 06-20069 (5th Cir. September 11, 2007)

For most homeowners, the only way to get flood insurance is through the National Flood Insurance Program administered by FEMA and backed by the U.S. federal treasury using Standard Flood Insurance Policy forms issued by qualifying insurance companies like Allstate.  The standard form provides that all disputes arising from claims-handling are governed by federal regulations and the National Flood Insurance Act of 1968 as amended.  Courts have uniformly interpreted this restriction to bar any state statute or common law remedies, including consumer protection or "bad-faith" remedies.

In this case, Mr. Wright asserts that an Allstate agent told him that his proof of loss was sufficient when in fact it lacked certain information required on the proof-of-loss form, which Allstate urges invalidated a substantial part of the claim.  Barred from asserting state law claims for fraud and misrepresentation, Mr. Wright seeks to assert these actions under federal common law.

The 5th Circuit reviewed the federal statute and found no basis for inferring that Congress intended to create any extracontractual remedies for claims under the flood insurance program and held that Mr. Wright's remedies are limited to those provided under his policy, basically breach of contract.  Although the court doesn't explicitly say what will happen to the Wright's claim, since the policy requires the proof of loss to contain the missing information, presumably that part of the claim is lost even though the agent's misinformation prevented the policyholder from timely amending the proof of loss.

Insurance Adjusters Face Personal Liability For Statutory Bad Faith In Texas

Insurance adjusters may find themselves as defendants in more insurance bad faith litigation after the Fifth Circuit Court of Appeals decision in Gasch v. Hartford Acc. & Indem. Co., 491 F.3d 278 (5th Cir. 2007), which held that federal courts had no diversity jurisdiction over an insurance bad faith action against an out-of-state insurer and an in-state adjuster because the adjuster was "a person in the business of insurance" and so could be liable under Texas Insurance Code art. 21.21 (now Sec. 541).  Federal diversity jurisdiction is destroyed when one defendant is a citizen of the same state as the plaintiff.  Therefore, although the lower court had dismissed the bad faith claims against both defendants as groundless, which the Fifth Circuit doesn't contest, the case was remanded to the lower court so it could dismiss the action, after which it would continue in state court.  This is not good news for adjusters.

In 1994, the Texas Supreme Court appeared to exonerate adjusters from bad-faith liability in Natividad v. Alexsis, Inc., 875 S.W.2d 695 (Tex. 1994), holding that adjusters under contract with insurers could not be held liable for common law bad faith because they were not parties to the contract between he insured and insurer.  However, since that time policyholders have gained more success pursuing both insurers and adjusters for mishandling claims under Texas' consumer protection statute in Art. 21.21 of the Insurance Code.  Under the statute, a party need not be in contractual privity with the insured to be liable.  It is enough if the party is engaged in "the business of insurance," which the Insurance Code explicitly defines to include investigating or adjusting claims (Sec. 101.501).

The Gasch court refused to apply the reasoning the the Natividad case and found that an adjuster can be liable for unfair claims settlement practices under Art. 21.21.  Because plaintiffs usually prefer to bring insurance lawsuits in state court, we can expect more lawsuits joining in-state defendants, especially local adjusters, to prevent insurers from removing state court actions to federal court.

Report Details Fraudulent Claims-Adjustment Practices in Homeowner Insurance Industry

In response to widespread insurance abuses reported in the 1960's and 1970's, many states, including Texas, instituted consumer protection laws to curb sharp practices and punish insurers that delay or refuse to pay meritorious claims.  According to a recent article by David Dietz and Darrell Preston published on Bloomberg.com (Home Insurers' Secret Tactics Cheat Fire Victims, Hike Profits), homeowners are facing a current wave of abuses designed to underpay property losses.  The authors provide numerous details of how such large insurers as Allstate and State Farm train adjusters to make low ball offers for damaged or destroyed homes and fight vigorously if the policyholder holds out for full replacement cost.

Perhaps most disturbing is evidence developed through discovery in several lawsuits across the country that insurers have relied on advice of consultants, particularly a New York-based consulting firm called McKinsey & Co., advising insurers on methods to raise profits by paying out less in claims.  For example, one powerpoint slide shown in a Kentucky court room entitled "Good Hands or Boxing Gloves" advises Allstate adjusters to make an initial low offer.  If the policyholder accepts the low offer, McKinsey's slide tells the adjuster to treat the person with good hands.  "If the customer protests or hires a lawyer, Allstate should fight back."

Another reported practice is the use of computer programs, including "Colossus" and "Xactimate," that allegedly calculate insured losses and systematically underpay policyholders without regard to the validity of each individual claim.  This article also reports on insurer practices of rewarding adjusters who underpay claims.

At a time when insurance company profits have increases year to year, despite Katrina-related losses (the article reports property-casualty profits up 49% in 2006), reports like these may well spur another cycle of consumer protection legislation.

Recent Case Provides Reality Check on Stowers and Gandy Doctrines

A recent Amarillo Court of Appeals case, Yorkshire Ins. Co. v. Seger, No. 07-05-00188-CV (April 30, 2007), gives the latest take on how Texas courts apply the Stowers and Gandy doctrines.  In a Stowers action, a policyholder is seeking extracontractual damages after its liability insurer negligently failed to accept a settlement demand within policy limits, resulting in a judgment against the policyholder in excess of policy limits.  Under the Stowers doctrine, the insurer is liable for the entire judgment, even the amount above policy limits.  In State Farm Fire & Cas. Co. v. Gandy, 925 S.W.2d 696 (Tex. 1996), the Texas Supreme Court effectively abolished what is known as the “sweetheart deal,” in which an insured defendant assigns to the plaintiff all of the insured’s claims against the insurer for extracontractual damages in return for a covenant not to execute any judgment or settlement against the defendant.  Gandy held, among other things. that such an assignment is effective against the insurer only if certain conditions are met, most importantly, that the plaintiff obtained a judgment against the insured defendant after “a fully adversarial trial” on the merits.

In the Seger case, an oil field rig collapsed and fell on a leased employee of the drilling contractor.  The decedent’s parents brought a wrongful death action against the contractor, who submitted the claim under its liability insurance, a Lloyds of London policy that is underwritten by multiple subscribing insurers, each of whose liability is limited only to the amount the insurer subscribed, not the usual joint and several liability on a non-Lloyds plan.  The insurers under the Lloyds policy denied coverage for a number of reasons.  Before trial, the plaintiffs sent several settlement demands, the lowest of which was within policy limits but above the individual limits of each subscriber separately.  The insurers refused to settle.

The contractor’s attorney withdrew from the case before trial.  At trial, the contractor’s representative appeared and testified but merely testified without putting on any opening or closing and did not cross-examine any other witnesses.  The court entered a judgment of $15,000,000.  On appeal, the reviewing court determined, among other things, that the plaintiffs had indeed submitted a legitimate Stowers demand because the amount of the policy limits under a Lloyds plan for Stowers purposes is the total sum of all subscribers’ limits, not a separate limit for each subscriber.  Therefore, the court upheld the trial court’s denial of the insurers’ summary judgment on this issue.  Score one for the insured.

Moreover, the court refused to accept the insurers’ argument that the contractor’s claims against the insurers were extinguished when the plaintiff gave the contractor a covenant not to execute in return for an assignment of the contractor’s claims against the insurers.  The insurers argued that the covenant not to execute effectively released the defendant of all liability, thereby absolving the insurers as well.  The court reminded the insurers that the rule under Texas law is that such s covenant might extinguish the claims that one insurer might assert against another insurer, but not those assigned by an insured to the underlying plaintiff.  Score two for the insured.

However, the court reversed the $15,000,000 judgment because, under Gandy, the underlying trial was not a fully adversarial trial on the merits.  Thus, the damage award was reversed.  Score the big one for the insurers.  As it turned out, the insurers prevailed on other coverage defenses in a related proceeding, so inquiry into the amount of damages is probably moot.

Insurance Cases Currently Pending Before the Texas Supreme Court

The Texas high Court has quite a backlog of pending insurance cases.  The following, from oldest to newest, is the list and key issues:

• Fairfield Ins. Co. v. Stephens Martin Paving, LP, No. 04-0728 (Pet. Granted: August 27, 2004)

Issue:  The U.S. Fifth Circuit Court of Appeals certified this question to the Texas Supreme Court:  Does Texas public policy prohibit a liability insurance company from paying a punitive damages award imposed on its insured because of gross negligence?  The issue here is whether Texas’s standard for finding gross negligence is so close to intentional conduct, which is uninsurable, that courts should disallow such coverage as a matter of public policy.  Currently, most Texas courts have held that punitive damages are covered unless explicitly excluded.

• Unauthorized Practice of Law Committee v. American Home Assur. Co., No. 04-0138 (Pet. Granted: April 08, 2005)

Issue:  Do insurance companies that use lawyers who are salaried employees in “captive” firms to defend policyholders practice law illegally?  And does an attorney hired by an insurer to defend its insured have an attorney-client relationship with the insurance company?  Like the Frank’s Casing case (see below), a decision in this case could clarify the duties owed by defense counsel to both insured and insurer.

• Mid-Continent Ins. Co. v. Liberty Mutual Ins. Co., No. 05-0261 (Pet. Granted: May 13, 2005)

Issue:  When two comprehensive general liability insurers carry the same limits on the same insured (and one also provided excess insurance coverage for the insured), and one settles for an amount greater than the other calculated for the insured’s liability and pays the disproportionately higher share, does the insurer that paid less owe a duty to reimburse the other insurer?  If the underpaying insurer might have such a duty to reimburse, does that duty derive from the underpaying insurer’s negligent valuation of the case, potentially justifying breach of a duty of good faith and fair dealing in a first-party claim, or a duty measured by some other standard?  If such a duty potentially exists, is it limited to a duty owed to the overpaying insurer regarding the amount it paid on the settlement under its excess policy?

• Lamar Homes Inc. v. Mid Continent Cas. Co., No. 05-0832 (Pet. Granted: November 04, 2005)

Issue:  The U.S. Fifth Circuit Court of Appeals certified this question to the Texas Supreme Court:  Do a homeowner’s allegations against his general contractor for construction defects resulting in damage to or loss of use of only the home itself, allege an “accident” or “occurrence” that triggers the duty to defend or indemnify under a commercial general liability insurance policy?  If so, can alleged defects of design or workmanship in and of themselves constitute “property damage”?  Finally, if the duty to defend is triggered by these allegations, is the insurer that wrongly refused to defend subject to delay penalties under Texas Insurance Code article 21.55 (now section 542.051)?

• Excess Underwriters at Lloyd’s, London, et al. v. Frank’s Casing Crew & Rental Tools Inc., No. 02-0730 (Pet. Granted:  January 06, 2006

Issue:  Should an excess insurer that disputes policy coverage be reimbursed for settling a lawsuit at the policyholder’s request when the policyholder did not also agree to the insurer’s right to seek reimbursement.  The troubling issues in this case are too complicated for a brief summary and are discussed more fully at Frank's Casing

• National Plan Administrators Inc v. National Health Ins. Co., No. 05-0006 (Pet. Granted:  January 20, 2006)

Issue:  Does a third-party administrator owe fiduciary duties to an insurer under the Texas Insurance Code when the insurer brings claims for breach of contract and breach of fiduciary duty against its plan administrator, and does the administrator owed a fiduciary duty to the insurer under terms of their contract?

• Mid-Century Ins. Co., v. Shefqet Ademaj, No. 05-0016 and Allstate Ins. Co. v. Cevia Fleming, No. 05-0645 (Pet. Granted: April 21, 2006)

Issue:  Is the Insurance Commission rule authorizing insurers to collect a statutory $1 fee from insureds to create the Texas Automobile Theft Prevention Authority prohibited by former Insurance Code article 21.35B(a) restricting insurers to collection of no more than items listed?

• PAJ Inc. v. The Hanover Ins. Co., No. 05-0849 (Pet. Granted: May 05, 2006)

Issue:  When an insured fails to give timely notice (i.e., as soon as practicable) of an advertising-injury claim, does the insurer have to prove that the delay prejudiced the defense, as it must with bodily injury and property damage claims?

• Fortis Benefits v. Vanessa Cantu and Ford Motor Co., No. 05-0791 (Pet. Granted: August 25, 2006)

Issue:  Does the “make-whole” doctrine (that gives a plaintiff the common law right to receive 100% of its damages first before insurers and benefit providers recover) trump an insurance policy’s subrogation or reimbursement clause?  In this case, the insurer sought to recover past medical expenses it had paid to the beneficiary who was rendered a paraplegic in an automobile accident, from her $1.4 million settlement of the underlying lawsuit.

• Evanston Ins. Co. v. ATOFINA Petrochemicals Inc., No. 03-0647 (Pet. Granted: October 27, 2006)

Issue:  In my opinion, the key issue in this case is whether an additional insured that is the sole defendant in a lawsuit may avoid a sole-negligence exclusion and require the named insured’s carrier to defend it simply by alleging contributory negligence against the plaintiff.  If so, how does this change the Court’s earlier rulings on the complaint-allegation rule under which a court is to determine the duty to defend solely by reference to the policy and the complaint (i.e., does the court now look at all pleadings, including the defendant’s counterclaim)?  For a discussion of the current status of the complaint-allegation rule, see Sentry Ins. v. DFW Alliance

• Farmers Group Inc. v. Jan Lubin, No. 05-0169 (Pet. Granted: October 27, 2006)

Issue:  Does Texas Insurance Code, Section 541.251(a), authorize the attorney general to bring a class action under the doctrine of parens patriae without meeting private class requirements, and has the attorney general met those requirements in this case?

• First American Title Ins. Co v. Comptroller of Public Accounts, No. 05-0541 (Pet. Granted: March 09, 2007)

Issue:  Does Texas comptroller’s interpretation of a “retaliatory” tax on out-of-state title-insurance companies violate guaranties of federal and state equal-protection?

• Ulico Cas. Co. v. Allied Pilots Ass’n, No. 06-0247 (Pet. Granted: March 09, 2007)

Issue:  If an insurer agrees to defend an insured in a lawsuit without a reservation of rights, even though the policy in fact does not cover the claim, and the insurer is aware of the grounds for non-coverage, may the insurer later refuse to cover the claim?  Also, if the insured prevails on the previous question, is the insured entitled to attorneys fees because the claim arose out of contract?

Federal Jury Awards $2.8 Million for Katrina Loss

Was the damage caused by wind or water?  That has become the crucial issue in most of these Katrina-related property damage cases.  In this case, a federal jury found that Robert Weiss's home was damaged by wind and hit Allstate Insurance Company with a sizable verdict, including $1.5 million in extra-contractual damages for failure to pay covered damages promptly.  The insurer argued that Mr. Weiss had already received $400,000 from flood insurance and other insurance and that wind could not have caused the extensive damage to the structure.The jury disagreed and found that this amount was not sufficient to pay for the wind damage.  See story at MSNBC.

Why Has the Frank’s Casing Decision Got Everybody So Stirred Up?

By David S. White

The Texas Supreme court ruled on this case in May 2005.  In response to a furor over the decision, the Court reheard oral argument (a very rare thing) in February 2006.  Now, more than a year later and after numerous amicus briefs submitted by interested parties representing the insurance industry, policyholders and the Texas defense bar, we still wait.  So what’s the big deal about Excess Underwriters at Lloyd’s London v. Frank’s Casing Crew and Rental Tools, Inc., No. 02-0730, 2005 WL 1252321 (Tex. May 27, 2005)? 

On its face, the opinion seems fairly unremarkable.  The decision held that a defending liability insurance company may accept a settlement of a lawsuit that the insured defendant agrees is reasonable and at the same time preserve the insurer’s right later to deny coverage for all or part of the settlement depending on the outcome of a separate coverage lawsuit.  If the insurer prevails, the insured must reimburse the settlement amount.  California adopted this approach in Buss v. Superior Court, 16 Cal. 4th 35 (Cal. 1994).  A few years earlier, the Texas High Court had refused to follow the Buss approach and held in Texas Association of Counties Country Government Risk Management Pool v. Matagorda County, 52 S.W.3d 128 (Tex. 2000) that an insurer that settled a lawsuit against its insured waived all rights to reimbursement from the insured if the insurer could show that some or all of the insured’s liability was never covered by the policy.  So the Texas Supreme Court has changed course.  Why the firestorm?

There is more at stake here than the Court simply changing its mind.  Frank’s Casing is potentially revolutionary because it may drastically change the traditional roles played in a lawsuit by the policyholder, the insurer, and defense counsel.

Now the Policyholder, Not the Insurer, Has to Be the Expert in Both Evaluating Claims and Insurance Coverage.

First, the ruling appears to shift the burden from the insurance company to the policyholder of figuring out both what is a fair and reasonable settlement and how strong are the insurance company’s coverage defenses.  The Court held that if the insurer has reserved its rights to deny coverage on specific grounds and the policyholder agrees that the settlement demand is reasonable (or urges the insurer to accept the settlement), then the insurer has preserved a right of reimbursement of the settlement upon showing that the claim was not covered by the insurance.  Moreover, the insured may not later argue that the settlement was too high.  If the insurer prevails on its coverage defenses, the policyholder must reimburse the insurer to the extent the settled claims were not covered.  Now the policyholder may have to bear the risk of paying too much in settlement.  The policyholder may also bear the risk of evaluating the insurer’s coverage defenses.  These are matters traditionally within the expertise of insurance companies that handle lawsuits for a living.  Policyholders, particularly if they are not sophisticated in handling lawsuits or in assessing coverage, are at a distinct disadvantage.

The Stowers Duty Is Diluted.

Texas and most states have long imposed a duty of care on insurers to protect policyholders from the risk of a judgment in excess of the policy limits if the insurer receives a settlement demand within policy limits that a reasonable person would accept.  If the insurer refuses to accept the settlement and gambles that defense counsel can avoid a judgment or get a judgment below policy limits, then the insurer bears the risk of having to pay a judgment in excess of the policy limits.  Frank’s Casing potentially absolves the insurer of this duty if the claims in fact are not covered.  So, what should the insured do?  If the insured urges the insurer to accept the settlement, the insured may not later balk at reimbursing the insurer the full settlement amount if the insured loses the coverage suit.  If the insured refuses to consent to the settlement, then the insured may have to pay the entire judgment if it loses the coverage suit — and, even if the insured wins the coverage suit, it might still have to pay any amount of judgment in excess of the policy limits because the insured prevented the insurer from accepting the Stowers demand.  The risks of getting it wrong are all on the insured.

Of course, if the policy clearly doesn’t cover the claim, then the insured has no right to expect the insurer to bear the ultimate liability.  But insurance coverage issues are often within a legal gray area, and even experienced coverage counsel cannot predict with relative certainty how a judge will rule on certain issues.  The insured must now make some hard choices that traditionally were left to the insurance company.

Defense Counsel May Be In an Impossible Position.

The other group complaining about Frank’s Casing is the defense bar.  As discussed above, much depends on the evaluation of the plaintiff’s case at trial, the merits of the case and the amount of likely damages.  Traditionally, defense counsel is in the best position to make that evaluation.  Very often defense counsel is hired by the insurance company to represent the insured defendant and provides case evaluation to both parties.  Arguably, however, the insured’s best option when faced with a plaintiff’s Stowers demand and the insurer’s reservation of rights is to stand mute —not urge acceptance or denial of the settlement demand.  In this way, the insured is neither agreeing that the settlement is reasonable nor preventing the insurer from exercising its own judgment to accept the demand.  However, if defense counsel opines that the settlement is reasonable, the insured may be bound by that opinion because defense counsel represents the insured.  Therefore, counsel might prejudice its client by making its opinion known.  Perhaps defense counsel should also stand mute.  However, even ignoring any duties defense counsel might owe to the insurer, many defense attorneys believe that they have an affirmative duty to provide the evaluation.  They may be damned if they do and damned if they don’t.

Marsh & McLennan Executives Start Trial

Accused of a bid-rigging scheme, two executives with insurance broker Marsh & McLennan Cos. begin trial In essence, Marsh allegedly arranged to place a policyholder's business with one insurance company but solicit phony bids from other insurers to create the illusion of a competitive bidding process.  For a fuller description of the proceedings, see Marsh Executives Go to Trial